Introduction to FOREX
Money talks. And nowhere does it talk more sweetly than at the Forex market!
Forex is the common term for the FOReign EXchange market. Trading more than a couple trillion dollars every day, the Forex market presents opportunities galore to day traders and investors alike.
In the days before the Internet became commonplace, Forex trading was the privy of the elite few. Forex trading was then restricted to major banks, hedge funds and big corporations. However, the widespread use of Internet has allowed many a small investors to actively trade in the Forex market.
The currency market, more commonly known as Forex has been particularly hot in recent years. This is a massive international market conducted around the world, with no centre of operation, unlike the stock markets. This is why it is claimed to be a 24/7 trading market, although only 5 1/2 days per week. Because there is no headquarters of the trading, estimates of the volume vary, but it’s roughly £2 trillion per day, which dwarfs any individual stock market.
In one way, the Forex market is much simpler than stock trading. There are only a certain number of currencies in the world, and in practice it’s usual to trade the “majors”, which are just six currency pairs – currencies are always traded in pairs, because currency exchanges must take place between two different countries’ money supplies.
Against that simplicity, there is the complication that you need to follow international affairs at times to help anticipate the fluctuations. The other trick to Forex trading is that you do not have to have lots of money to trade significant amounts of currency because of a thing called “margin”, which you will also come across in other trading. Margin simply means that you effectively borrow money from your broker or dealer to make your trades – you pay a small percentage of the value that you are trading, but you can profit from the change in price of the whole amount. Before you get too excited, you must realize that you can also lose from the change in price of the whole amount if you trade the wrong way, and that means that your account can be wiped out very quickly if you are not cautious – in fact, you can lose more than your original stake. This applies most times you are trading on margin, and not just to the Forex market.
Another truth you must realize about Forex trading is that there are winners and losers. For every person who holds a winning currency trade, someone is on the other side of that trade and has lost. It’s basically a zero sum game, except that the dealers will also take their percentage for operating their business, so more is lost than is gained. Forex is the most obvious example of this, but this principle applies to most markets when you are talking about trading, which is basically a short-term activity. Even with stocks, it is rare that there will be much underlying change in worth in the short term.
Forex Trading Instruments
Like the stock exchange market, Forex trading instrument include forward deals, futures, options, spreads, as well as the spot market. Forex trading requires a minimum market size of major currencies to ensure liquidity in the market. Further, Forex trading Exchanges charge margins to ensure safety of all the Forex trades.
One of the most important differences in the Forex trading (vis-à-vis share trading or commodity trading) is that currencies are always associated in pairs. The first currency is called as the base currency , and the second currency is called as the counter or quote currency . All Forex trades result in the purchase of one currency and the simultaneous selling of the other.
Thus, while trading Forex, you should buy a currency only if you feel the currency will increase in value relative to the one you are selling. Profits are booked only when you again sell the currency with which you have exchanged it.
Forex Trading Quotes
Forex trading quotes always include a bid and an ask price. The bid price is the price at which the trader offers to buy the base currency in exchange for the quote / counter currency. Likewise, the ask price is the price at which the market maker will sell the base currency in exchange for the counter currency. Spread is the difference between the bid and the ask prices (akin to the jobbing margin in shares).
The Forex market offers currency trading 24 hours a day, five days a week. It is the largest and one of the most liquid markets in the world. Brokerage firms and banks are connected via the electronic medium that allow them to convert the currencies of almost all countries in the world.
Because a large number of currencies can be traded, the Forex market offers many opportunities to the shrewd investor. Like the equity market, Forex trading offers a variety of instruments to maximize the return potentials and minimize risks. The icing on the cake of course is that the Forex trading charges are nil or very less.